THE IMPACT OF US LNG ON RUSSIAN NATURAL GAS EXPORT POLICY BY TATIANA MITROVA AND TIM BOERSMA DECEMBER 2018 ABOUT THE CENTER ON GLOBAL ENERGY POLICY The Center on Global Energy Policy provides independent, balanced, data-driven analysis to help policymakers navigate the complex world of energy. We approach energy as an economic, security, and environmental concern. And we draw on the resources of a world- class institution, faculty with real-world experience, and a location in the world’s finance and media capital. Visit us at www.energypolicy.columbia.edu @ColumbiaUenergy ABOUT THE SCHOOL OF INTERNATIONAL AND PUBLIC AFFAIRS SIPA’s mission is to empower people to serve the global public interest. Our goal is to foster economic growth, sustainable development, social progress, and democratic governance by educating public policy professionals, producing policy-related research, and conveying the results to the world. Based in New York City, with a student body that is 50 percent international and educational partners in cities around the world, SIPA is the most global of public policy schools. For more information, please visit www.sipa.columbia.edu THE IMPACT OF US LNG ON RUSSIAN NATURAL GAS EXPORT POLICY BY TATIANA MITROVA AND TIM BOERSMA DECEMBER 2018 1255 Amsterdam Ave New York NY 10027 www.energypolicy.columbia.edu @ColumbiaUenergy THE IMPACT OF US LNG ON RUSSIAN NATURAL GAS EXPORT POLICY ACKNOWLEDGEMENTS For comments on earlier drafts of this paper and editorial guidance, the authors would like to thank Jason Bordoff, Jonathan Elkind, Anna Galkina, Matthew Robinson, Morena Skalamera, Rik Komduur, and Megan Burak. All remaining errors are the authors’ own. The opinions expressed in this report should not be construed as reflecting the views of the Columbia SIPA Center on Global Energy Policy or any other entity. This work was made possible by support from the Center on Global Energy Policy. More information is available at: https://energypolicy.columbia.edu/about/mission. 3 | ­­ CENTER ON GLOBAL ENERGY POLICY | COLUMBIA SIPA THE IMPACT OF US LNG ON RUSSIAN NATURAL GAS EXPORT POLICY ABOUT THE AUTHORS Dr. Tatiana Mitrova is a Fellow at the Center on Global Energy Policy and the Director of the SKOLKOVO Energy Centre in Moscow. From 2011-2012, she was the head of global energy at the SKOLKOVO Energy Centre, responsible for analysis of the global energy market and the Russian Federation’s energy export and import policy. From 2006-2011, she was head of the Center for International Energy Markets Studies at Energy Research Institute of the Russian Academy of Sciences, and since 2011 she is scientific director at Oil and Gas Department, . Dr. Tim Boersma is a Senior Research Scholar and Director of Global Natural Gas Markets at the Center on Global Energy Policy. Prior to joining CGEP, Boersma was a Fellow and Acting Director of the Energy Security and Climate Initiative at the Brookings Institution, and worked in the Dutch electricity sector. ENERGYPOLICY.COLUMBIA.EDU | DECEMBER 2018 ­­ | 4 THE IMPACT OF US LNG ON RUSSIAN NATURAL GAS EXPORT POLICY TABLE OF CONTENTS Executive Summary 07 Introduction 09 Two Completely Different Types of Gas Market Organization 09 Russian and US Production and Export Volumes 10 Russia’s Role during the US Gas Deficit 12 The Current Impact of US LNG on Russian Gas Exports 14 Death of Shtokman Project and Delay of Yamal-LNG 15 The United States Creates Global LNG Glut 15 The US LNG Argument Became a Tool to Obtain Better Prices from Gazprom 18 Growing Pressure on Russia to Speed Up the New Pipeline Projects 18 Implications for the Domestic Russian Gas Market Framework 20 The Future Impact of Growing US LNG Supplies on Russian Gas Exports: Commercial, Geopolitical, and Institutional Competition 22 Direct Commercial Competition 22 European Market 22 Expectations of LNG Oversupply in Europe 22 Unique European Two-Segment Gas Market Model: Locked-in LTCs 23 Gazprom Secured the Biggest Portfolio of LTCs in Europe 25 Gazprom’s LTC Prolongation in Europe 26 Gazprom Selling at Spot 27 Volume in Europe Will Be Defined by LTCs 28 Long-Run Marginal Cost Competitiveness 28 SRMC Competitiveness 30 The Asian Market 32 Asian Buyers Are Looking for Risk Diversification 32 5 | ­­ CENTER ON GLOBAL ENERGY POLICY | COLUMBIA SIPA THE IMPACT OF US LNG ON RUSSIAN NATURAL GAS EXPORT POLICY LRMC and SRMC Competitiveness 33 Geopolitical Competition 34 Europe: Supporting European Energy Security or Marketing US LNG? 35 Asia: Who Will Tame the Dragon? 36 Fundamental Competition between the Two Institutional Systems 37 The Empire Strikes Back: Russia’s Potential Response and Gas Export Policy Scenarios 40 Potential Financial Consequences for Gazprom and the Russian Budget 40 Gazprom’s Strategy in Europe Will Depend on the Market Conjuncture: Asian Gas Demand and Oil Prices 40 No Change/Manipulation 42 Avoiding Competition 42 Adaptation and More Proactive Market Strategy 43 Adaptation/Price War 44 Conclusion 46 Bibliography 47 Notes 52 ENERGYPOLICY.COLUMBIA.EDU | DECEMBER 2018 | 6 THE IMPACT OF US LNG ON RUSSIAN NATURAL GAS EXPORT POLICY EXECUTIVE SUMMARY The United States and Russia have long been the world’s largest natural gas producers, but they traditionally have not faced off in direct competition in that market. The United States was expected to become a net importer of natural gas, while Russia’s state-owned Gazprom took a prominent position in the European market. The boom in US shale-gas production changed that. While the United States had been trading gas regionally by pipeline for decades, the shale boom allowed for the export of US liquefied natural gas, putting the two gas giants in competition. Even before the first molecule of US LNG shipped, rising US production had diverted LNG destined for the United States into the European Union. Facing increased competition pushed Russia toward a more market-oriented strategy, with Gazprom adjusting its long-term oil-linked contracts that had previously been the backbone of Russian sales to European customers to use more hybrid formulae. This was just the beginning. After a slow start, the competition brought on by US gas is to a large extent shaping the Russian natural gas strategy in Europe and beyond. For Europe, rising gas competition from new suppliers has both economic and energy security implications. Globally, it is also raising questions about how Gazprom will compete in Asia, where demand is growing and gas suppliers are looking to place future production, as well as in other markets. Understanding how Gazprom will react to US gas is thus a critical economic and geopolitical question for LNG importers and exporters worldwide. In this paper the authors examine how Gazprom will maneuver in global markets under specific circumstances. It opens with a discussion of how the US and Russian gas sectors developed and interacted in the period before shale gas. The paper then examines how Gazprom’s gas trade has been impacted by new US production and what changes may be coming as US exports continue to increase. It finds that the advent of US LNG has already reduced Russian gas revenue, undermined its oil-linked pricing model, forced contract renegotiations and accelerated domestic gas market liberalization and LNG development. The authors argue that Russia is in a good position to defend its market share in Europe and looks at some of the strategies that could be pursued under various market scenarios, including the following: ● High Asian demand and low oil prices: If oil-linked gas prices were pushed below spot prices, Gazprom would not need to further adjust its pricing policy (as was the case in 2015–2017). In certain situations Gazprom might even limit supplies to drive prices up and increase its rent, becoming the price maker. Such a strategy would be utilized cautiously to avoid demand destruction and prompting new FIDs for new (US) liquefaction capacity. ● High Asian demand and high oil prices: In this scenario Gazprom’s position would be well served in the short to medium term by strong revenues. In the longer term, however, high prices will attract more competitors to the markets (and prompt new FIDs), so it is important for Gazprom to keep its own prices competitive and to keep the margin of the 7 | ­­ CENTER ON GLOBAL ENERGY POLICY | COLUMBIA SIPA THE IMPACT OF US LNG ON RUSSIAN NATURAL GAS EXPORT POLICY aggregators, which are supplying the European market, below their margin in Asia. There are already almost no “pure” oil-linked contracts left, and Gazprom in Europe mainly has hybrid pricing, but this scenario will require a more fundamental shift in the pricing, with the share of spot-indexed prices becoming dominant. ● Low Asian demand and low oil prices: Gazprom may be forced to keep prices for its long-term contracts below short-run marginal costs of US LNG. Gazprom might voluntarily move to completely spot-indexed prices, simultaneously trying not only to find new markets for its gas (both in Asia and in Europe) but also to stimulate new demand. The company would need more flexible and creative marketing, and it would seek to improve the efficiency of its operations, both internationally and domestically. Should Gazprom start to see its market share decline, Moscow could decide to liberalize the pipeline export monopoly, a decision that would make Novatek and Rosneft more powerful players. ● Low Asian demand and high oil prices: Russia would feel competitive pressure not only from the United States but also from all existing low-cost LNG suppliers like Qatar, which may have to switch to Europe and keep gas prices at a low level. Gazprom would have to engage in this price competition as well, flooding the market using spare capacities and driving the prices down to the level of its short-run marginal costs, which will disincentive US LNG aggregators to offtake their LNG.